The $1 Million Retirement Nest Egg Myth

Jeff Brown, Special to CNBC.com

Wednesday, 22 May 2013 | 11:50 AM ETCNBC.com

SHARES

Echo | Cultura | Getty Images

It seems like everyone's goal: Become a millionaire! Have a cool million and live on easy street in retirement. No worries. Lots of fun. And you don't have to be a Wall Street banker to do it. Lots of middle-class folks amass a million. How could you do it?

There are lots of people mentioned in the personal finance press—from professionals espousing wisdom to the lucky guy case studies—who offer surefire steps to Millionaire's Club membership through investing. The press is replete with headlines such as, "How to Retire at 40," "5 Simple Steps to a $1 Million Retirement Nest Egg," "How to Retire With a Million Dollars" ... etc., etc.

The truth doesn't make for quite as enticing a headline, though. For starters, the best advice for the hopeful millionaire retiree is to not trust any headline purporting to have cracked the wealth riddle in x number of easy steps.

And if you think clicking on one article can provide an answer to all of your anxiety about wealth accumulation, you have really only learned one important lesson, a lesson you didn't expect: You have a lot more work to do beyond that article if you want to have any hope of investing and retiring successfully.

The best an individual investor can do in setting up a framework for success is to commit to a list of core investing disciplines. If they seem obvious, simple or easy, it's because these are key conceptual frames, but in no way a "lock" for investment success. In fact, they have as much to do with how you live your daily Main Street life as they do Wall Street practices.

Start earlier

Save more

Retire later

"The key to building wealth is establishing good habits of living below your means and saving," said Richard Feight, a certified financial planner with IAM Financial in Okemos, Mich.

Before we get into the details, notice what's not on the list—any expectation of a stupendous investment return. Sure, you could get to $1 million sooner if your stocks, bonds and mutual funds earned 15 percent or 20 percent a year, as they have on occasion. But don't count on it.

"Investors should plan on earning 5 percent to 7 percent after fees on a well-diversified balanced portfolio, depending on how aggressively they invest in stocks and how skillfully they manage their bond holdings," said Steve Merrell, a financial advisor with Monterey Private Wealth in Monterey, Calif.

So if big investment returns are not the way to make a million, how can those other steps help?

Start Earlier

The key here is the "magic of compounding." The longer your money has to grow, the bigger the nest egg will get. You could amass $1 million in 30 years by investing $7,715 over the next year, earning 7 percent a year, and increasing the annual contribution by 3 percent every year, assuming your income rises to match inflation. But if you saved for 40 years, you would have to start with only $3,415—less than half as much.

Save More

What if your saving rates started at $10,000 a year instead of $7,715? With the same 7 percent return you'd have about $1.3 million after 30 years instead of $1 million. You'd hit the $1 million mark after about 27 years, perhaps speeding your retirement.

Of course, to save more you must spend less.

"It really is a double-whammy positive effect," said Mitch Marsden, a financial planner with Longview Financial Advisors in Huntsville, Ala., of tighter budgeting. "You not only boost the amount of your nest egg because you are putting away more for long-term saving, but you are also spending less, which means a lifestyle that won't require as much net cash each month in retirement," which reduces the overall size of a nest egg needed for a comfortable retirement.

Retire Later

This obviously has the same effect as starting earlier, giving your savings more time to grow. But there are a couple of additional benefits that can help determine whether the $1 million goal is actually necessary.

First, retiring later means starting your Social Security benefits later, which makes them larger. If you were entitled to $2,000 a month at a "full" retirement age of 66, you'd get just $1,500 if you started benefits at 62, or $2,640 if you waited to 70. If you were lucky enough to have a traditional pension, it, too, would probably be larger if you started later. The more you receive from these sources, the less you need from your nest egg, so it can be smaller.

The second benefit of retiring later is having fewer retirement years to fund—eight less if you retired at 70 instead of 62.

If you assume you'd live to 100 and your nest egg would earn 5 percent a year, your $1 million would produce annual income of about $37,000 if you started drawing from it at 62. (Annual withdrawals would increase at the 3 percent inflation rate.) Wait until 70 and you'd get the same income from a nest egg of $846,000. Or, if you had $1 million at 70, you could withdraw about $43,500 a year.

"Retiring later can help a great deal," said Brian Goodstadt, an advisor with Paragon Capital Management in Denver. "For example, for a 60-year-old couple with $1 million in assets, I estimate that for every additional year they work and earn $50,000, their annual spending rate can increase by about $1,000. Therefore, work another five years and they can spend an additional $5,000 a year for the rest of their lives."

Of course, all this assumes that $1 million is a good target. Is that really enough? That depends on many other factors, such as how much you expect in Social Security and any pension, how long you will live and how much income you'll want or need. The Internet offers many calculators for analyzing this issue, including this simple one and this elaborate one.

"The $1 million figure is sort of a mystical figure for most nonsavers, but it actually isn't that much," said Feight.

A million dollars not enough, not even in three, five or seven simple steps? It seems Easy Street isn't as simple to reach as the journey is often presented.